The latest US inflation data for January has been released, confirming that price pressures remain elevated.
The core Personal Consumption Expenditures (PCE) price index, the Federal Reserve's preferred measure of inflation, rose by 0.4% in January, following an identical increase in December. On an annualized basis, this is close to 5%, which is significantly higher than the Fed's 2% target. This result validates the cautious stance Fed Chair Jerome Powell expressed recently, when he noted there had been 'no progress' on core inflation over the past year.
However, this sticky inflation data is only part of a more complex story. Two major events have unfolded since this data was collected, creating a difficult puzzle for policymakers. First, the war in Iran and the resulting blockade of the Strait of Hormuz have caused a sharp spike in oil prices, with Brent crude jumping from around $72 to $100 per barrel. This will almost certainly push up headline inflation in the coming months through higher gasoline and transportation costs.
Second, the February jobs report showed a surprising cooling of the labor market, with a loss of 92,000 jobs and the unemployment rate rising to 4.4%. A weaker job market would typically strengthen the case for interest rate cuts. But when combined with rising oil prices, it raises the uncomfortable risk of stagflation—a scenario of slowing growth and rising inflation.
This puts the Fed in a bind. The persistent inflation makes it difficult to justify a rate cut, but the weakening labor market is a growing concern. Therefore, the most probable course of action at the upcoming March FOMC meeting is to hold interest rates steady and adopt a wait-and-see approach. The January PCE data, while important, is ultimately backward-looking because it doesn't capture the oil shock. The inflation reports for March, April, and May will be the true test and will likely determine whether the first rate cut happens in June, July, or even later in the year.
- PCE (Personal Consumption Expenditures): A measure of U.S. consumer spending on goods and services. The PCE price index is the Federal Reserve's primary gauge for inflation.
- Core Inflation: An inflation measure that excludes volatile food and energy prices to show the underlying trend.
- Stagflation: An economic condition characterized by slow economic growth, high unemployment, and rising prices (inflation).